Exchange merger is Step 1 toward Moscow goal

Moscow aims to become financial center but quest will be arduous

By

PolyaLesova

LONDON (MarketWatch) — Moscow has a lot riding on a new exchange.

The city’s RTS and Micex exchanges recently announced they will merge, in hopes of simplifying the investment process, boosting liquidity and attracting more investors. The consolidated group would rank ninth world-wide in market capitalization and somewhere below 15th in revenue as of 2010—and officials hope to reach the top 10 in both within five years.

Russian officials see the marriage as the first step in a much broader effort: turning the capital into a financial hub that draws businesses and investors from abroad. But the quest is likely to be long and arduous.

Moscow—and Russia—must overcome a reputation for widespread corruption, poor infrastructure and a murky legal system. And that will mean implementing institutional reforms and improving the business environment—measures the government has long discussed but never carried out.

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“The single trading platform is very good,” said Lilit Gevorgyan, country analyst at IHS Global Insight. “On the other hand, you cannot have this infrastructure isolated from the general business environment in Russia, which has been deteriorating.”

Some experts think Russia has little choice but to take the reform agenda seriously, since it sorely needs foreign investment. Though the country has a fast-growing economy and lots of natural resources, it suffers big swings in its equity markets, and investors rush for the exits during crises. That happened after the 2008 financial crash, and the economy contracted violently.

Already, says Ivan Tchakarov, chief economist at Renaissance Capital in Moscow, Russia is running a fiscal deficit, and in three years’ time will run a current-account deficit. The 2008 crisis “was a wake-up call,” Tchakarov said. “The Russian authorities were really humbled by this crisis.… Russia will need foreign money to finance this deficit. It’s a totally new macroeconomic paradigm for this government.”

Reuters

The exchange's opening and closing bell is seen at the trading floor of the Moscow Interbank Currency Exchange.

Russia created the exchanges in the wake of another crisis: the collapse of the Soviet Union. The Micex, which stands for Moscow Interbank Currency Exchange, was founded in 1992 by Russia’s central bank and leading commercial banks and became a leader in stocks, bonds and foreign exchange. Its smaller rival, RTS, or Russian Trading System, came along three years later and took the lead in derivatives.

The two exchange groups have their own clearinghouses and depositories, so investors have had to open separate accounts to do business with each exchange. The merger will create one large trading platform and will smooth the way toward settling big-picture issues, like establishing a central depository.

Micex will hold around 75% of the combined exchange, with RTS taking 25%. The initial public offering of the joint exchange is planned for 2013.

“There is a lot of complementarity between our groups,” said Micex President Ruben Aganbegyan, who will be CEO of the combined exchange. “With combining, we can provide many more services and effectively reduce costs.”

Many industry experts also have high hopes for the deal. “Russia is a big equity market, but I don’t think it needs two exchanges,” said Roland Nash, senior partner at Verno Capital in Moscow. “The merger moves toward creating a world-class exchange, and that is a necessary condition if Moscow is ever going to become a financial center.”

Long road ahead

Still, there’s a lot more work to be done. Investors have a laundry list of concerns about the Russian market—among them corruption, red tape, a weak judicial system and lack of protection for the rights of minority shareholders.

Transparency International’s 2010 Corruption Perceptions Index, which ranks 178 countries according to perception of corruption in the public sector, had Russia at 154th place, at the same level as Papua New Guinea and Tajikistan. Its score: 2.1 on a scale from zero (highly corrupt) to 10 (very clean).

Russia has guarded jealously the state’s role in industries considered strategically important. Its business sector is dominated by large state-controlled companies such as banking group Sberbank, oil producer Rosneft and gas giant Gazprom. In recent years, a series of high-profile cases—from the challenges faced by BP PLC and Royal Dutch Shell PLC to the imprisonment of Mikhail Khodorkovsky, the former head of oil company Yukos—have underscored that in Russia political power often trumps the rule of law.

“The plan of turning Moscow into a financial center will remain a dream unless the fundamental issues are addressed,” said Gevorgyan of IHS. “Russia has to work on its image. This is being reinforced by the scandals. Over the last decade, that’s the image that has developed—of the strong state that comes in and crushes business when it is in its interest.”

Moscow itself needs a lot of work, too. Analysts say the city needs to upgrade its infrastructure—from roads to apartments and offices—and become a more attractive place to live and work if it hopes to attract star traders and bankers. Moscow ranked 61st out of 75 cities on the Global Financial Centers Index produced by the London-based Z/Yen think tank in September this year; that marked an improvement from its No. 68 ranking in the March survey.

Russian President Dmitry Medvedev, who has said that creating a financial center is a critical task, has proposed numerous economic reforms, including decentralizing power, reducing the state’s role in the country’s biggest companies, fighting corruption and strengthening the rule of law. Working groups within the government are hammering out plans and working with international consultants to figure out what Moscow needs to become a successful hub.

“Just the fact that they are taking it seriously is a major step forward,” said Mark Yeandle from Z/Yen, who is working with the Russian government on the effort. “They are spending a considerable amount of money to find out what makes a center more successful.”

Some think all the clean-up efforts are worthwhile even if Russia doesn’t reach its goal. “The aim of becoming a financial center, even if Moscow never makes it, allows the reformers in Russia to do a lot of the necessary reforms anyway,” Nash said. “It is a nice, easily communicable, proud Russia aim. To create a financial center, you need to bring down inflation. You need to improve the number of investors in Russia. That’s great anyway.”

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